Unformatted text preview: , they may not give the same ranking of projects,
which is a problem in case of mutually exclusive projects. Download free ebooks at bookboon.com
26 Corporate Finance Risk, return and opportunity cost of capital 5. Risk, return and opportunity cost of capital
Opportunity cost of capital depends on the risk of the project. Thus, to be able to determine the
opportunity cost of capital one must understand how to measure risk and how investors are compensated
for taking risk. 5.1 Risk and risk premia
The risk premium on financial assets compensates the investor for taking risk. The risk premium is the
difference between the return on the security and the risk free rate.
To measure the average rate of return and risk premium on securities one has to look at very long time
periods to eliminate the potential bias from fluctuations over short intervals.
Over the last 100 years U.S. common stocks have returned an average annual nominal compounded rate of
return of 10.1% compared to 4.1% for U.S. Treasu...
View Full Document